Inflation Panic Doesn’t Make a Lot of Sense

Back to blogging. Mostly on macro. Trying to keep it shorter and less tidy and therefore hopefully more likely to publish.

“The cure for high prices is… high prices.”

A lot of people are expecting high inflation to persist. Forgetting this bit of market wisdom “The cure for high prices is… high prices.” So lets have a look.

Where are we? When you get a conflict between absolute conviction among amateurs and/or commentators with a financial interest in the game and deep uncertainty and nuance from the people actually playing the game, uncertainty usually wins.

  1. A whole bunch of popular press commentators will, with total confidence, tell you exactly what the Fed has been doing and its impacts.
  2. Meanwhile, the Fed itself has been EXTREMELY clear they are not all confident about what impact monetary policy (especially Quantitative Easing) has had. Or if it has had any impact at all. The world of “real economists” is equally uncertain and honest about it.

So what do we really know? The stimulus was powerful.

  1. We do know Fiscal stimulus (giving people $$) was extremely powerful and effective over the last 2 years. It had major impact. Whether criticizing or praising the stimulus, most people agree on that.
  2. We also know that fiscal stimulus is fading. We can see it in the data.

So where do we go from here? [sound of air hissing out of a tire…]

  1. Consumers with less money facing higher prices will do…. what? BUY LESS STUFF. The cure for higher prices is… higher prices.
  2. This other bit of wisdom seems particularly apt after 2 years of people shifting spending to buying goods vs services. “I have seen gluts that did not lead to shortages but I have never seen a shortage that did not lead to a glut.
  3. Also remember that higher oil and gas prices are usually set aside as a more like a tax than an “inflation” price input. Meaning that higher prices work like a tax increase (deflationary). More spending at the pump reduces spending elsewhere. You could make the same argument about higher rents. If you spend more on shelter, you spend less elsewhere.

So is there a realistic case for persistently high inflation?

  1. The ONLY path for inflation to take hold is a so-called wage-price spiral. That takes few cycles around the track to get going. Wage increases now only count if they are followed by wage increase in 2023 and 2024 AT LEAST. A one time gain for workers in 2022 is just that. a one-time gain.
  2. If workers don’t keep clawing out wage gains, they end up reducing spending (or going into debt). That debt capacity is pretty good after all that stimulus. But this is basically just a return to the 2008-2019 economic dynamic. This wasn’t inflationary.
  3. So if you are predicting inflation, you are predicting workers will be able to demand raises for the next few years.
  4. You are predicting a meaningful shift in the balance of bargaining power between labor and capital.
  5. You are (really) predicting a shift in inequality. The poor get richer. Profits suffer as wages increase. The rich get poorer.
  6. Is that really a high-probability scenario? I don’t think so.

With respect to inflation and markets. Companies with pricing power ride it OK. Companies without pricing power get squeezed.

Also note that basically no-one has a really good handle on the connection between inflation and money printing or really anything at all (stripping out the Zimbabwe or Weimar Germany examples which are clearly not relevant here). Honest people are willing to admit that. See this Fed paper, which can be summed up as “we have no idea what causes inflation and most of the tidy explanations don’t hold up vs real data.

Click to access 2021062pap.pdf

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